External equity represents the perception of employees of a company’s pay structure and compensation system. In a market society, companies most often need to pay the market rate in order to hire competent employees. Paying below the market rate results in negative external equity as individuals do not see value in working for the business. Compensation rates above the market rate will attract more potential employees, but there is no guarantee these individuals are better than those paid at the market rate. Companies can gauge their perceived external equity through a review of internal and external human resource factors.
Like all activities in a market economy, hiring and compensating employees can fall under a traditional supply-and-demand curve. The demand curve — on a right-angle graph — slopes from the top left to the bottom right. The supply curve is opposite, sloping from the top right to the bottom left. The intersection of the two lines indicates the current equilibrium point, that is, the point where a company can hire and compensate the most employees at a specific level. This point, however, may not actually fall where a company can achieve maximum external equity.
A company may find it difficult to determine its true external equity point. The biggest problem here is that employees — and other individuals, such as potential employees — may hold a different opinion on the company’s pay structure and compensation. For example, a company may believe it is competitive in its compensation plans based on current market guidelines. Employees, however, may not believe the amount of work for the specific compensation is actually worthwhile. Overcoming this divide is among the biggest issues a company must deal with in order to rectify this perceived inequality.
A compensation plan often includes salaries or wages and a certain number of benefits. The salary or wage depends on the market rate paid to individuals at a standard rate. This rate can vary widely depending on how important the position is to the company. Companies that pay lower wages in terms of the market rate may offset this compensation with better benefits. Benefit packages that include insurance coverage, paid time off, and retirement account matching may all be ways for a company to increase its external equity.
The level of employee skills required for a job position may dictate the corresponding compensation. Higher skills required from employees tend to increase compensation. The equity from employees may also be higher. Lower-skilled positions pay lower compensation and may be viewed with lower external equity by outside individuals.
